I have been saying for some time that the continuation of the rally will be strongly influenced by the "net news flow." That is a subjective concept, as obviously reasonable minds can differ over whether a day's or a week's flow of news was on balance positive, negative, or so-so.
Not this week. The news was almost unrelentingly negative:
- Robert Shiller, of the widely followed Case-Shiller home price index fame, stated that he believes home prices will move sideways for five years.
- Mortgage loan delinquencies increased to 5.4% in Q2.
- Initial unemployment claims increased to 551,000 in the latest reporting week.
- The ISM Manufacturing Survey fell after several months of increases. Its employment component worsened slightly to 46.2 (a reading under 50 signals contraction).
- Consumer confidence fell in September.
- Today's Labor Department report was dismal. The nation's job losses accelerated in September, driving the unemployment rate to a 26-year high of 9.8%. Nonfarm payrolls fell by a greater-than-expected 263,000 in September, the 21st consecutive month of job losses. Since the recession began in December 2007, 7.2 million jobs have been lost and the unemployment rate has doubled. The number of unemployed people rose by 214,000 to 15.1 million. And of those, 5.4 million have been out of work longer than six months, accounting for a record 36% of the jobless. More than a half a million people dropped out of the labor force, and the employment participation rate fell to 65%, the lowest in 23 years. The average duration of unemployment rose above 26 weeks, a record high. An alternative gauge of unemployment, which includes discouraged workers and those with part-time employment, rose to 17% -- the highest in the 15-year history of the data. Total hours worked in the economy fell by 0.5%. The average workweek dropped back to an all-time low of 33 hours.
There is no way to depict this week's net news flow as anything other than disastrous. I don't "rate" every week's news flow, but I don't think there's been a week this bad since the rally started in March.
The S&P 500 fell this week from 1044 to 1025, or about 2%. And that illustrates the relationship between news flow and the market: The market is sentiment-driven, and sentiment is driven by news and the interpretation of the news. Bad news week = bad market week.
No time for panic yet (actually, there's never any need to panic, just follow cool portfolio management practices). The market is down just 4% from its most recent high, and it is still up 52% from its March low. Next week begins the earnings season for Q3, during which official earnings reports and their accompanying verbiage will provide much of the news flow.
In the last earnings season, about 75% of companies reported earnings that "surprised to the upside," meaning they exceeded analyst's expectations. That created a fairly steady positive news flow for weeks that helped the rally along tremendously. This time, it may be more difficult for companies to impress the market, given that most of last quarter’s positive surprises were due to severe cost-cutting, not revenue growth. Eyes will be on revenue growth as well as profits this time around.
To me, the two most important potential threats to the rally are consumer spending and unemployment. Both speak directly to revenue growth as somewhere between 65% and 70% of the U.S. economy consists of consumer spending. Most data suggest that the "average consumer" has become more conservative in day-to-day spending. This is demonstrated by lagging store sales, deleveraging of personal credit, and higher savings rates. There's no telling how long these trends will last, but common sense suggests they are closely tied to the job market--whether people have jobs and how secure they feel their job is. We're somewhere around the tipping point now: The recession is probably close to being technically over, but that is not yet reflected in the job market. If this becomes a "jobless recovery," or if there is a "double dip" recession as some are predicting, the stock market rally will probably fizzle out.
